Read the description for the type of "rest" necessary for wizards to prepare their spells.
The wizard does not have to slumber for every minute of the time, but must refrain from movement, combat, spellcasting, skill use, conversation, or any other fairly demanding physical or mental task during the rest period. If the wizard's rest is interrupted, each interruption adds 1 hour to the total amount of time the wizard has to rest in order to clear his or her mind, and the wizard must have at least 1 hour of rest immediately prior to preparing spells. If the wizard does not need to sleep for some reason, the character still must have 8 hours of restful calm before preparing any spells.
Basically, yes, you can have an elf on watch... but he's not going to be very useful. He has to be mentally very relaxed, and he can't move. This means that the wizard cannot make spot or listen checks, and means he'd be pretty useless on watch.
Now, this doesn't mean he's COMPLETELY useless of course. You don't need to make listen checks in order to hear people talking to you... and saying one or two words now and again doesn't qualify as "conversation" in my book. Similarly, you don't need to make a spot check to see the ground, or the road you're traveling on, or people sitting next to you... so if someone strolls into the camp, or shouts hello from nearby, the wizard should be able to respond.
A rogue trying to sneak into the camp would get by easily. No matter how badly the rogue is sneaking, the wizard would still have to make a spot or listen check.
However, if the camp were being surrounded by Dire Wolves that were spread a radius of 20' around the camp, and they were howling at the moon and about to attack... the wizard could see that, and at least do something like shout a warning to the other party members without breaking his relaxation.